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Warren Buffett on the Stock Market
What's in the future for investors --another roaring bull
market or more upset stomach? Amazingly, the answer
may come down to three simple factors. Here, the world's
most celebrated investor talks about what really makes the
market tick--and whether that ticking should make you
Monday, December 10, 2001
By Carol Loomis
The Oracle of
Omaha in his office

Two years ago, following a July 1999 speech

by Warren Buffett, chairman of Berkshire
Hathaway, on the stock market --a rare subject FEATURES
for him to discuss publicly --FORTUNE ran Introduction
what he had to say under the title Mr. Buffett Warren Buffett on the Stock
on the Stock Market (Nov. 22, 1999). His main Market
points then concerned two consecutive and
12 Stocks for a Tough
amazing periods that American investors had
experienced, and his belief that returns from
stocks were due to fall dramatically. Since the Big Retailers: Getting
Dow Jones Industrial Average was 11194 Malled
when he gave his speech and recently was Gap: Fashion Victim
about 9900, no one yet has the goods to argue 10 Big Reasons to Smile
with him. What's the Best Fund
Manager Buying Now?
So where do we stand now --with the stock Building a Global Portfolio
market seeming to reflect a dismal profit
outlook, an unfamiliar war, and rattled LISTS & TOOLS
consumer confidence? Who better to supply Year-End Financial Planner
perspective on that question than Buffett? Quiz: How Much Risk Can
You Take?
The thoughts that follow come from a second America's Best and Worst
Buffett speech, given last July at the site of the Wealth Creators
first talk, Allen & Co.'s annual Sun Valley bash Wealth Creators: The List
for corporate executives. There, the renowned
stockpicker returned to the themes he'd BEST OF BUFFETT
discussed before, bringing new data and The Value Machine
insights to the subject. Working with
Mr. Buffett on the Stock
FORTUNE's Carol Loomis, Buffett distilled that
speech into this essay, a fitting opening for this
Buffett on Leading in a
year's Investor's Guide. Here again is Mr.
Buffett on the Stock Market.
Buffett: The Market After
The last time I tackled this subject, in 1999, I
Warren Buffett: Revivalist
broke down the previous 34 years into two 17 -
year periods, which in the sense of lean years
and fat were astonishingly symmetrical. Here's the first period. As you can see,
over 17 years the Dow gained exactly one -tenth of one percent. 12/12/2001 Page 2 of 11

• Dow Jones Industrial Average

Dec. 31, 1964: 874.12
Dec. 31, 1981: 875.00

And here's the second, marked by an incredible bull market that, as I laid out my
thoughts, was about to end (though I didn't know that).

• Dow Industrials
Dec. 31, 1981: 875.00
Dec. 31, 1998: 9181.43

Now, you couldn't explain this remarkable divergence in markets by, say,
differences in the growth of gross national product. In the first period --that dismal
time for the market--GNP actually grew more than twice as fast as it did in the
second period.

• Gain in Gross National Product

1964 -1981: 373%
1981 -1998: 177%

So what was the explanation? I concluded that the market's contrasting moves
were caused by extraordinary changes in two critical economic variables --and by
a related psychological force that eventually came into play.

Here I need to remind you about the definition of "investing," which though simple
is often forgotten. Investing is laying out money today to receive more money

That gets to the first of the economic variables that affected stock prices in the two
periods --interest rates. In economics, interest rates act as gravity behaves in the
physical world. At all times, in all markets, in all parts of the world, the tiniest
change in rates changes the value of every financial asset. You see that clearly
with the fluctuating prices of bonds. But the rule applies as well to farmland, oil
reserves, stocks, and every other financial asset. And the effects can be huge on
values. If interest rates are, say, 13%, the present value of a dollar that you're
going to receive in the future from an investment is not nearly as high as the
present value of a dollar if rates are 4%.

So here's the record on interest rates at key dates in our 34 -year span. They
moved dramatically up--that was bad for investors --in the first half of that period
and dramatically down --a boon for investors--in the second half.

• Interest Rates, Long-Term Government Bonds

Dec. 31, 1964: 4.20%
Dec. 31, 1981: 13.65%
Dec. 31, 1998: 5.09%

The other critical variable here is how many dollars investors expected to get from
the companies in which they invested. During the first period expectations fell
significantly because corporate profits weren't looking good. By the early 1980s
Fed Chairman Paul Volcker's economic sledgehammer had, in fact, driven
corporate profitability to a level that people hadn't seen since the 1930s.

The upshot is that investors lost their confidence in the American economy: They
were looking at a future they believed would be plagued by two negatives. First,
they didn't see much good coming in the way of corporate profits. Second, the
sky-high interest rates prevailing caused them to discount those meager profits
further. These two factors, working together, caused stagnation in the stock 12/12/2001 Page 3 of 11

market from 1964 to 1981, even though those years featured huge improvements
in GNP. The business of the country grew while investors' valuation of that
business shrank!

And then the reversal of those factors created a period during which much lower
GNP gains were accompanied by a bonanza for the market. First, you got a major
increase in the rate of profitability. Second, you got an enormous drop in interest
rates, which made a dollar of future profit that much more valuable. Both
phenomena were real and powerful fuels for a major bull market. And in time the
psychological factor I mentioned was added to the equation: Speculative trading
exploded, simply because of the market action that people had seen. Later, we'll
look at the pathology of this dangerous and oft -recurring malady.

Two years ago I believed the favorable fundamental trends had largely run their
course. For the market to go dramatically up from where it was then would have
required long-term interest rates to drop much further (which is always possible)
or for there to be a major improvement in corporate profitability (which seemed, at
the time, considerably less possible). If you take a look at a 50 -year chart of after-
tax profits as a percent of gross domestic product, you find that the rate normally
falls between 4% --that was its neighborhood in the bad year of 1981, for example -
-and 6.5%. For the rate to go above 6.5% is rare. In the very good profit years of
1999 and 2000, the rate was under 6% and this year it may well fall below 5%.

So there you have my explanation of those two wildly different 17-year periods.
The question is, How much do those periods of the past for the market say about
its future?

To suggest an answer, I'd like to look back over the 20th century. As you know,
this was really the American century. We had the advent of autos, we had aircraft,
we had radio, TV, and computers. It was an incredible period. Indeed, the per
capita growth in U.S. output, measured in real dollars (that is, with no impact from
inflation), was a breathtaking 702%.

The century included some very tough years, of course --like the Depression years
of 1929 to 1933. But a decade-by-decade look at per capita GNP shows
something remarkable: As a nation, we made relatively consistent progress
throughout the century. So you might think that the economic value of the U.S.--at
least as measured by its securities markets --would have grown at a reasonably
consistent pace as well.

The U.S. Never Stopped Growing

Per capita GNP gains crept in the 20th century's early years. But if you think of the U.S. as a
stock, it was overall one helluva mover.

growth in per
capita GNP
Year (constant dollars)
1900-10 29%
1910-20 1%

1920-30 13%
1930-40 21%
1940-50 50%

1950-60 18%
1960-70 33% 12/12/2001 Page 4 of 11

1970-80 24%
1980-90 24%

1990-2000 24%

That's not what happened. We know from our

earlier examination of the 1964 -98 period that
parallelism broke down completely in that era. FEATURES
But the whole century makes this point as well. Introduction
At its beginning, for example, between 1900 Warren Buffett on the Stock
and 1920, the country was chugging ahead, Market
explosively expanding its use of electricity,
12 Stocks for a Tough
autos, and the telephone. Yet the market
barely moved, recording a 0.4% annual
increase that was roughly analogous to the Big Retailers: Getting
slim pickings between 1964 and 1981. Malled
Gap: Fashion Victim
10 Big Reasons to Smile
• Dow Industrials
Dec. 31, 1899: 66.08 What's the Best Fund
Dec. 31, 1920: 71.95 Manager Buying Now?
Building a Global Portfolio
In the next period, we had the market boom of
the '20s, when the Dow jumped 430% to 381 in LISTS & TOOLS
September 1929. Then we go 19 years--19 Year-End Financial Planner
years--and there is the Dow at 177, half the Quiz: How Much Risk Can
level where it began. That's true even though You Take?
the 1940s displayed by far the largest gain in America's Best and Worst
per capita GDP (50%) of any 20th -century Wealth Creators
decade. Following that came a 17-year period Wealth Creators: The List
when stocks finally took off--making a great
five-to -one gain. And then the two periods BEST OF BUFFETT
discussed at the start: stagnation until 1981, The Value Machine
and the roaring boom that wrapped up this
Mr. Buffett on the Stock
amazing century. Market
Buffett on Leading in a
To break things down another way, we had Crisis
three huge, secular bull markets that covered
Buffett: The Market After
about 44 years, during which the Dow gained 9/11
more than 11,000 points. And we had three
Warren Buffett: Revivalist
periods of stagnation, covering some 56 years.
During those 56 years the country made major
economic progress and yet the Dow actually lost 292 points.

How could this have happened? In a flourishing country in which people are
focused on making money, how could you have had three extended and
anguishing periods of stagnation that in aggregate --leaving aside dividends --
would have lost you money? The answer lies in the mistake that investors
repeatedly make--that psychological force I mentioned above: People are
habitually guided by the rear-view mirror and, for the most part, by the vistas
immediately behind them.

The first part of the century offers a vivid illustration of that myopia. In the
century's first 20 years, stocks normally yielded more than high -grade bonds. That
relationship now seems quaint, but it was then almost axiomatic. Stocks were
known to be riskier, so why buy them unless you were paid a premium?

And then came along a 1924 book --slim and initially unheralded, but destined to 12/12/2001 Page 5 of 11

move markets as never before --written by a man named Edgar Lawrence Smith.
The book, called Common Stocks as Long Term Investments, chronicled a study
Smith had done of security price movements in the 56 years ended in 1922. Smith
had started off his study with a hypothesis: Stocks would do better in times of
inflation, and bonds would do better in times of deflation. It was a perfectly
reasonable hypothesis.

But consider the first words in the book: "These studies are the record of a failure -
-the failure of facts to sustain a preconceived theory." Smith went on: "The facts
assembled, however, seemed worthy of further examination. If they would not
prove what we had hoped to have them prove, it seemed desirable to turn them
loose and to follow them to whatever end they might lead."

Now, there was a smart man, who did just about the hardest thing in the world to
do. Charles Darwin used to say that whenever he ran into something that
contradicted a conclusion he cherished, he was obliged to write the new finding
down within 30 minutes. Otherwise his mind would work to reject the discordant
information, much as the body rejects transplants. Man's natural inclination is to
cling to his beliefs, particularly if they are reinforced by recent experience --a flaw
in our makeup that bears on what happens during secular bull markets and
extended periods of stagnation.

To report what Edgar Lawrence Smith discovered, I will quote a legendary thinker -
-John Maynard Keynes, who in 1925 reviewed the book, thereby putting it on the
map. In his review, Keynes described "perhaps Mr. Smith's most important
point ... and certainly his most novel point. Well-managed industrial companies do
not, as a rule, distribute to the shareholders the whole of their earned profits. In
good years, if not in all years, they retain a part of their profits and put them back
in the business. Thus there is an element of compound interest (Keynes' italics)
operating in favor of a sound industrial investment."

It was that simple. It wasn't even news. People certainly knew that companies
were not paying out 100% of their earnings. But investors hadn't thought through
the implications of the point. Here, though, was this guy Smith saying, "Why do
stocks typically outperform bonds? A major reason is that businesses retain
earnings, with these going on to generate still more earnings --and dividends, too."

That finding ignited an unprecedented bull market. Galvanized by Smith's insight,

investors piled into stocks, anticipating a double dip: their higher initial yield over
bonds, and growth to boot. For the American public, this new understanding was
like the discovery of fire.

But before long that same public was burned. Stocks were driven to prices that
first pushed down their yield to that on bonds and ultimately drove their yield far
lower. What happened then should strike readers as eerily familiar: The mere fact
that share prices were rising so quickly became the main impetus for people to
rush into stocks. What the few bought for the right reason in 1925, the many
bought for the wrong reason in 1929.

Astutely, Keynes anticipated a perversity of this kind in his 1925 review. He wrote:
"It is dangerous ... to apply to the future inductive arguments based on past
experience, unless one can distinguish the broad reasons why past experience
was what it was." If you can't do that, he said, you may fall into the trap of
expecting results in the future that will materialize only if conditions are exactly the
same as they were in the past. The special conditions he had in mind, of course,
stemmed from the fact that Smith's study covered a half century during which
stocks generally yielded more than high -grade bonds.

The colossal miscalculation that investors made in the 1920s has recurred in one 12/12/2001 Page 6 of 11

form or another several times since. The public's monumental hangover from its
stock binge of the 1920s lasted, as we have seen, through 1948. The country was
then intrinsically far more valuable than it had been 20 years before; dividend
yields were more than double the yield on bonds; and yet stock prices were at
less than half their 1929 peak. The conditions that had produced Smith's
wondrous results had reappeared --in spades. But rather than seeing what was in
plain sight in the late 1940s, investors were transfixed by the frightening market of
the early 1930s and were avoiding re -exposure to pain.

Don't think for a moment that small investors

are the only ones guilty of too much attention
to the rear -view mirror. Let's look at the FEATURES
behavior of professionally managed pension Introduction
funds in recent decades. In 1971 --this was Warren Buffett on the Stock
Nifty Fifty time--pension managers, feeling Market
great about the market, put more than 90% of
12 Stocks for a Tough
their net cash flow into stocks, a record
commitment at the time. And then, in a couple
of years, the roof fell in and stocks got way Big Retailers: Getting
cheaper. So what did the pension fund Malled
managers do? They quit buying because Gap: Fashion Victim
stocks got cheaper! 10 Big Reasons to Smile
What's the Best Fund
• Private Pension Funds Manager Buying Now?
% of cash flow put into equities Building a Global Portfolio
1971: 91% (record high)
1974: 13% LISTS & TOOLS
Year-End Financial Planner
This is the one thing I can never understand. Quiz: How Much Risk Can
To refer to a personal taste of mine, I'm going You Take?
to buy hamburgers the rest of my life. When America's Best and Worst
hamburgers go down in price, we sing the Wealth Creators
"Hallelujah Chorus" in the Buffett household. Wealth Creators: The List
When hamburgers go up, we weep. For most
people, it's the same way with everything in life BEST OF BUFFETT
they will be buying --except stocks. When The Value Machine
stocks go down and you can get more for your Mr. Buffett on the Stock
money, people don't like them anymore.
Buffett on Leading in a
That sort of behavior is especially puzzling Crisis
when engaged in by pension fund managers, Buffett: The Market After
who by all rights should have the longest time
horizon of any investors. These managers are
Warren Buffett: Revivalist
not going to need the money in their funds
tomorrow, not next year, nor even next decade.
So they have total freedom to sit back and relax. Since they are not operating with
their own funds, moreover, raw greed should not distort their decisions. They
should simply think about what makes the most sense. Yet they behave just like
rank amateurs (getting paid, though, as if they had special expertise).

In 1979, when I felt stocks were a screaming buy, I wrote in an article, "Pension
fund managers continue to make investment decisions with their eyes firmly fixed
on the rear -view mirror. This generals -fighting -the-last -war approach has proved
costly in the past and will likely prove equally costly this time around." That's true,
I said, because "stocks now sell at levels that should produce long-term returns
far superior to bonds."

Consider the circumstances in 1972, when pension fund managers were still 12/12/2001 Page 7 of 11

loading up on stocks: The Dow ended the year at 1020, had an average book
value of 625, and earned 11% on book. Six years later, the Dow was 20%
cheaper, its book value had gained nearly 40%, and it had earned 13% on book.
Or as I wrote then, "Stocks were demonstrably cheaper in 1978 when pension
fund managers wouldn't buy them than they were in 1972, when they bought them
at record rates."

At the time of the article, long-term corporate bonds were yielding about 9.5%. So
I asked this seemingly obvious question: "Can better results be obtained, over 20
years, from a group of 9.5% bonds of leading American companies maturing in
1999 than from a group of Dow -type equities purchased, in aggregate, around
book value and likely to earn, in aggregate, about 13% on that book value?" The
question answered itself.

Now, if you had read that article in 1979, you would have suffered --oh, how you
would have suffered!--for about three years. I was no good then at forecasting the
near -term movements of stock prices, and I'm no good now. I never have the
faintest idea what the stock market is going to do in the next six months, or the
next year, or the next two.

But I think it is very easy to see what is likely to happen over the long term. Ben
Graham told us why: "Though the stock market functions as a voting machine in
the short run, it acts as a weighing machine in the long run." Fear and greed play
important roles when votes are being cast, but they don't register on the scale.

By my thinking, it was not hard to say that, over a 20 -year period, a 9.5% bond
wasn't going to do as well as this disguised bond called the Dow that you could
buy below par--that's book value --and that was earning 13% on par.

Let me explain what I mean by that term I slipped in there, "disguised bond." A
bond, as most of you know, comes with a certain maturity and with a string of little
coupons. A 6% bond, for example, pays a 3% coupon every six months.

A stock, in contrast, is a financial instrument that has a claim on future

distributions made by a given business, whether they are paid out as dividends or
to repurchase stock or to settle up after sale or liquidation. These payments are in
effect "coupons." The set of owners getting them will change as shareholders
come and go. But the financial outcome for the business' owners as a whole will
be determined by the size and timing of these coupons. Estimating those
particulars is what investment analysis is all about.

Now, gauging the size of those "coupons" gets very difficult for individual stocks.
It's easier, though, for groups of stocks. Back in 1978, as I mentioned, we had the
Dow earning 13% on its average book value of $850. The 13% could only be a
benchmark, not a guarantee. Still, if you'd been willing then to invest for a period
of time in stocks, you were in effect buying a bond --at prices that in 1979 seldom
inched above par --with a principal value of $891 and a quite possible 13% coupon
on the principal.

How could that not be better than a 9.5% bond? From that starting point, stocks
had to outperform bonds over the long term. That, incidentally, has been true
during most of my business lifetime. But as Keynes would remind us, the
superiority of stocks isn't inevitable. They own the advantage only when certain
conditions prevail.

Let me show you another point about the herd

mentality among pension funds --a point 12/12/2001 Page 8 of 11

perhaps accentuated by a little self-interest on

the part of those who oversee the funds. In the
table below are four well-known companies-- FEATURES
typical of many others I could have selected -- Introduction
and the expected returns on their pension fund Warren Buffett on the Stock
assets that they used in calculating what Market
charge (or credit) they should make annually
12 Stocks for a Tough
for pensions.
Big Retailers: Getting
Now, the higher the expectation rate that a Malled
company uses for pensions, the higher its
Gap: Fashion Victim
reported earnings will be. That's just the way
10 Big Reasons to Smile
that pension accounting works--and I hope, for
the sake of relative brevity, that you'll just take What's the Best Fund
my word for it. Manager Buying Now?
Building a Global Portfolio
As the table below shows, expectations in
1975 were modest: 7% for Exxon, 6% for GE LISTS & TOOLS
and GM, and under 5% for IBM. The oddity of Year-End Financial Planner
these assumptions is that investors could then Quiz: How Much Risk Can
buy long -term government noncallable bonds You Take?
that paid 8%. In other words, these companies America's Best and Worst
could have loaded up their entire portfolio with Wealth Creators
8% no -risk bonds, but they nevertheless used Wealth Creators: The List
lower assumptions. By 1982, as you can see,
they had moved up their assumptions a little BEST OF BUFFETT
bit, most to around 7%. But now you could buy The Value Machine
long-term governments at 10.4%. You could in
Mr. Buffett on the Stock
fact have locked in that yield for decades by Market
buying so-called strips that guaranteed you a
Buffett on Leading in a
10.4% reinvestment rate. In effect, your idiot
nephew could have managed the fund and
achieved returns far higher than the investment Buffett: The Market After
assumptions corporations were using. 9/11
Warren Buffett: Revivalist
Why in the world would a company be
assuming 7.5% when it could get nearly 10.5% on government bonds? The
answer is that rear-view mirror again: Investors who'd been through the collapse
of the Nifty Fifty in the early 1970s were still feeling the pain of the period and
were out of date in their thinking about returns. They couldn't make the necessary
mental adjustment.

Now fast -forward to 2000, when we had long-term governments at 5.4%. And
what were the four companies saying in their 2000 annual reports about
expectations for their pension funds? They were using assumptions of 9.5% and
even 10%.

I'm a sporting type, and I would love to make a large bet with the chief financial
officer of any one of those four companies, or with their actuaries or auditors, that
over the next 15 years they will not average the rates they've postulated. Just look
at the math, for one thing. A fund's portfolio is very likely to be one -third bonds, on
which --assuming a conservative mix of issues with an appropriate range of
maturities --the fund cannot today expect to earn much more than 5%. It's simple
to see then that the fund will need to average more than 11% on the two -thirds
that's in stocks to earn about 9.5% overall. That's a pretty heroic assumption,
particularly given the substantial investment expenses that a typical fund incurs.

Heroic assumptions do wonders, however, for the bottom line. By embracing

those expectation rates shown in the far right column, these companies report
much higher earnings --much higher --than if they were using lower rates. And 12/12/2001 Page 9 of 11

that's certainly not lost on the people who set the rates. The actuaries who have
roles in this game know nothing special about future investment returns. What
they do know, however, is that their clients desire rates that are high. And a happy
client is a continuing client.

Are we talking big numbers here? Let's take a look at General Electric, the
country's most valuable and most admired company. I'm a huge admirer myself.
GE has run its pension fund extraordinarily well for decades, and its assumptions
about returns are typical of the crowd. I use the company as an example simply
because of its prominence.

If we may retreat to 1982 again, GE recorded a pension charge of $570 million.

That amount cost the company 20% of its pretax earnings. Last year GE recorded
a $1.74 billion pension credit. That was 9% of the company's pretax earnings. And
it was 2 1/2 times the appliance division's profit of $684 million. A $1.74 billion
credit is simply a lot of money. Reduce that pension assumption enough and you
wipe out most of the credit.

GE's pension credit, and that of many another corporation, owes its existence to a
rule of the Financial Accounting Standards Board that went into effect in 1987.
From that point on, companies equipped with the right assumptions and getting
the fund performance they needed could start crediting pension income to their
income statements. Last year, according to Goldman Sachs, 35 companies in the
S&P 500 got more than 10% of their earnings from pension credits, even as, in
many cases, the value of their pension investments shrank.

Shifting Views

Expected pension fund returns

1975 1982 2000
Exxon 7.0% 7.8% 9.5%

General Electric 6.0% 7.5% 9.5%

General Motors 6.0% 7.0% 10.0%
IBM 4.8% 5.5% 10.0%

Yield on long-term government 8.0% 10.4% 5.5%


Unfortunately, the subject of pension

assumptions, critically important though it is,
almost never comes up in corporate board FEATURES
meetings. (I myself have been on 19 boards, Introduction
and I've never heard a serious discussion of Warren Buffett on the Stock
this subject.) And now, of course, the need for Market
discussion is paramount because these
12 Stocks for a Tough
assumptions that are being made, with all eyes
looking backward at the glories of the 1990s,
are so extreme. I invite you to ask the CFO of a Big Retailers: Getting
company having a large defined-benefit Malled
pension fund what adjustment would need to Gap: Fashion Victim
be made to the company's earnings if its 10 Big Reasons to Smile
pension assumption was lowered to 6.5%. And What's the Best Fund
then, if you want to be mean, ask what the Manager Buying Now?
company's assumptions were back in 1975 Building a Global Portfolio
when both stocks and bonds had far higher 12/12/2001 Page 10 of 11

prospective returns than they do now.

Year-End Financial Planner
With 2001 annual reports soon to arrive, it will Quiz: How Much Risk Can
be interesting to see whether companies have You Take?
reduced their assumptions about future
America's Best and Worst
pension returns. Considering how poor returns
Wealth Creators
have been recently and the reprises that
probably lie ahead, I think that anyone Wealth Creators: The List
choosing not to lower assumptions --CEOs,
auditors, and actuaries all--is risking litigation BEST OF BUFFETT
for misleading investors. And directors who The Value Machine
don't question the optimism thus displayed Mr. Buffett on the Stock
simply won't be doing their job. Market
Buffett on Leading in a
The tour we've taken through the last century Crisis
proves that market irrationality of an extreme Buffett: The Market After
kind periodically erupts--and compellingly 9/11
suggests that investors wanting to do well had Warren Buffett: Revivalist
better learn how to deal with the next outbreak.
What's needed is an antidote, and in my opinion that's quantification. If you
quantify, you won't necessarily rise to brilliance, but neither will you sink into

On a macro basis, quantification doesn't have to be complicated at all. Below is a

chart, starting almost 80 years ago and really quite fundamental in what it says.
The chart shows the market value of all publicly traded securities as a percentage
of the country's business--that is, as a percentage of GNP. The ratio has certain
limitations in telling you what you need to know. Still, it is probably the best single
measure of where valuations stand at any given moment. And as you can see,
nearly two years ago the ratio rose to an unprecedented level. That should have
been a very strong warning signal.

For investors to gain wealth at a rate that exceeds the growth of U.S. business,
the percentage relationship line on the chart must keep going up and up. If GNP
is going to grow 5% a year and you want market values to go up 10%, then you
need to have the line go straight off the top of the chart. That won't happen.

For me, the message of that

chart is this: If the
percentage relationship falls
to the 70% or 80% area,
buying stocks is likely to work
very well for you. If the ratio
approaches 200% --as it did
in 1999 and a part of 2000 --
you are playing with fire. As
you can see, the ratio was
recently 133%.

Even so, that is a good -sized

drop from when I was talking
about the market in 1999. I
ventured then that the
American public should
expect equity returns over
the next decade or two (with
dividends included and 2%
inflation assumed) of
perhaps 7%. That was a gross figure, not counting frictional costs, such as
commissions and fees. Net, I thought returns might be 6%. 12/12/2001 Page 11 of 11

Today stock market "hamburgers," so to speak, are cheaper. The country's

economy has grown and stocks are lower, which means that investors are getting
more for their money. I would expect now to see long-term returns run somewhat
higher, in the neighborhood of 7% after costs. Not bad at all --that is, unless you're
still deriving your expectations from the 1990s.

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